Contract of Guarantee

Taking risks doesn’t sound good. But what if the risks were calculated? Life never provides any sort of guarantee; but what if some things in life were guaranteed? Legally? Let us understand how.

The Indian Contract Act, 1872 has provisions for a ‘Contract of Guarantee’ under its section number 126. In the legal language, “Section 126 of the Indian Contract Act, 1872, says that a Contract of Guarantee is a contract to perform the promise or discharge the liability or a third person in case of his default.” We shall understand this by breaking up the stated definition.

A Guarantee could be an assurance of many things, for example:

A Guarantee of a particular result

A Guarantee of fulfilling a third party’s responsibilities, financial or otherwise

A Guarantee of executing something

A Guarantee of completion of something

A Guarantee of something to be done in a particular manner

This list is far from exhaustive. These examples are just a few. Under a ‘Contract of Guarantee’ there are always three parties:

The one who borrows or is liable to pay i.e. Principal Debtor

The one who is to receive the payment i.e. Creditor

The one who gives the guarantee for the Principal Debtor i.e. Surety or Guarantor

…And there are two contracts:

The main/principal contract between the principal debtor and creditor

The secondary contract between the creditor and the surety

Scenario #1

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Kevin wants a loan. Sammy can give the same to him. Due to some financial difficulties in the past he had defaulted on a previous loan. He cleared it eventually. Now Kevin’s business is going smoothly and he wants a loan for expansion. Due to his past records, Sammy is quite hesitant to lend him the money. A common acquaintance, Raphael stands as a Surety. He tells Sammy that he is sure that this time Kevin will pay you the money, in case he doesn’t, Raphael himself will pay the amount to Sammy.

Scenario #2

Kate wants to buy a consignment of cosmetic products. Siera is a distributor of EyeLash Cosmetics. Kate likes to deal in the products of EyeLash cosmetics and approaches Siera on 2nd May 2015 to buy the consignment on a 3 months’ credit. Siera doubts Kate’s credibility and is not comfortable selling the same on credit. Kate and Siera agree upon the fact that Akon is ready to stand as a Surety. Akon’s name holds a lot of credibility in their line of business. Akon states that in case Kate does not pay up on the completion of the 3 months’ period, he shall make the entire payment to Siera in cash. The primary contract between Kate and Siera is signed on 5th of May 2015 and the secondary contract between Akon and Siera (stating that Akon is standing in as the Surety) is signed on the same day subsequently. On 4th Of July, after repeated attempts to contact Kate, she is not reachable. There is confirmed news in the market that Kate is absconding. Akon plays his part and makes the payment to Sieral.

The Contract of Guarantee is not because the Surety wants the Principal Debtor to fail in keeping his promise, but, it is so that he keeps his side of the bargain. Following are some other key aspects of this section

The underlying intention is for the principal debtor to discharge his/her duty. So a debt has to be a prerequisite.

Any basic principles of a valid contract are also applicable to the Contract of Guarantee. These include legal objective, free consent.

Unlike other contracts under the Indian Contract Act, the principal debtor (one of the parties to the contract) can be a minor (a party incompetent to contract).

The Contract of Guarantee can be either orally stated or given in writing.